First In, First Out (FIFO)
Reviewed by Aug 27, 2020| Updated on
First In, First Out, also known as FIFO is a method for valuation of assets or inventories. Under the method, the goods that are produced first are disposed of first. The method also finds a place in the Indian accounting standards for inventory valuation. From a tax perspective, under FIFO, the cost of goods sold consists of the goods produced first and so on.
Understanding First In First Out
First In, First Out (FIFO) is part of an accounting method where assets which are acquired first are sold of first. The method FIFO considers the inventory as consisting of items bought in the end. The method of FIFO is contrary to another method LIFO in which goods purchased in the last are sold first. In general under the FIFO method, under inflationary market conditions, the older costs or those lower are assigned as costs to the goods sold. This results in an increase in the net income of the company. The balance quantity of inventory will include goods which are bought last or purchases in the recent past. The assignment of costs happens at the time of a sale. The assignment happens in the order in which the goods are purchased or in the order in which the goods are manufactured. The FIFP method requires that what comes in first goes out first. For example, if a batch of 1000 items gets manufactured in the first week of a month, and another batch of 1000 in the second week, then the batch produced first gets sold first. The logic behind the FIFO method is to avoid obsolescence of inventory. Hence, a company sells or assigns the cost of the first batch of production to the first sale. Accordingly, the oldest goods get disposed of first while the new ones remain in stock. An entity must choose a method carefully and should follow it consistently.
There are several valuation methods such as FIFO, LIFO or average cost. A company can choose any method of valuation. However, the method chosen should suit the company’s business and must be followed with consistency. Also the method of stock valuation affects the income of the company.